Define long-term assets,

LO 1 Define long-term assets,

within one year or during its operating cycle, whichever is longer. They also and explain the management differ from current assets in that they support the operating cycle, rather than issues related to them. being part of it. Although there is no strict rule for defining the useful life of

a long-term asset, the most common criterion is that the asset be capable of repeated use for at least a year. Included in this category is equipment used only in peak or emergency periods, such as electric generators.

씰 They are used in the operation of a business. Assets not used in the normal course of business, such as land held for speculative reasons or buildings no

longer used in ordinary business operations, should be classified as long-term To be classified as property,

Study Note

investments, not as long-term assets.

plant, and equipment, an 씰 They are not intended for resale to customers. An asset that a company assest must be “put in use,”

which means it is available intends to resell to customers should be classified as inventory—not as a long-

for its intended purpose. An term asset—no matter how durable it is. For example, a printing press that a

emergency generator is “put manufacturer offers for sale is part of the manufacturer’s inventory, but it is a in use” when it is available for

long-term asset for a printing company that buys it to use in its operations. emergencies, even if it is never

Figure 9-1 shows the relative importance of long-term assets in various indus- used. tries. Figure 9-2 shows how long-term assets are classified and defines the meth-

ods of accounting for them. Plant assets, which are tangible assets, are accounted for through depreciation, the periodic allocation of the cost of a tangible long- lived asset over its estimated useful life. (Although land is a tangible asset, it is not

Study Note

depreciated because it has an unlimited life.) Natural resources, which are also

A computer that a company tangible assets, are accounted for through depletion, the proportional allocation uses in an office is a long-

of the cost of a natural resource to the units extracted. Most intangible assets are term plant asset. An identical

accounted for through amortization, the periodic allocation of the cost of the computer that a company sells

asset to the periods it benefits. However, some intangible assets, including good- to customers is considered

will, are not subject to amortization if their fair value is below the carrying value. inventory.

Carrying value (also called book value) is the unexpired part of an asset’s cost (see Figure 9-3). Long-term assets are generally reported at carrying value. If a

FIGURE 91 Long-Term Assets as a Percentage

21.0% of Total Assets for Selected Industries

Auto and Home Supply

Grocery

Stores

Machinery

Management Issues Related to Long-Term Assets

FIGURE 92 Classification of Long-Term Assets and Methods of Accounting for Them

BALANCE SHEET

INCOME STATEMENT

Long-Term Assets

Expenses

Tangible Assets: long-term assets that have physical substance

Land

Land is not expensed because it has an unlimited life.

Plant, Buildings, Equipment (plant assets)

Depreciation: periodic allocation of the cost of a tangible long-lived asset (other than land and natural resources) over its estimated useful life

Natural Resources: long-term assets purchased for the economic value that can be taken from the land and used up, as with ore, lumber, oil, and gas or other resources contained in the land

Mines

Depletion: exhaustion of a natural

Timberland

resource through mining, cutting, pumping, or other extraction, and

Oil and Gas Fields

the way in which the cost is allocated

Intangible Assets: long-term assets that have no physical substance but have a value based on rights or advantages accruing to the owner

Patents, Copyrights, Software,

Amortization: periodic allocation

Trademarks, Licenses, Brands, Franchises,

of the cost of an intangible asset to the

Leaseholds, Noncompete Covenants,

periods it benefits

Customer Lists, Goodwill

long-term asset loses any of its potential to generate revenue before the end of its useful life, it is deemed impaired, and its carrying value is reduced.

All long-term assets, including intangible assets that are not subject to amor-

tization, are subject to an annual impairment evaluation. Asset impairment To be classified as intangible,

Study Note

occurs when the carrying value of a long-term asset exceeds its fair value. 2 Fair an asset must lack physical

value is the amount for which the asset could be bought or sold in a current substance, be long term,

transaction. For example, if the sum of the expected cash flows from an asset is and represent a legal right or

less than its carrying value, the asset would be impaired. Reducing carrying value advantage.

to fair value, as measured by the present value of future cash flows, is an applica- tion of conservatism. A reduction in carrying value as the result of impairment is recorded as a loss. When the market prices used to establish fair value are not available, the amount of an impairment must be estimated from the best available information.

FIGURE 93 Carrying Value of Long-Term Assets on the Balance Sheet

CHAPTER 9 Long-Term Assets In 2004, Apple recognized losses of $5.5 million in asset impairments, but

it recognized none in subsequent years. A few years earlier, in the midst of an economic slowdown in the telecommunications industry, WorldCom recorded asset impairments that totaled $79.8 billion, the largest impairment write-down in history. Since then, other telecommunications companies, including AT&T and Qwest Communications , have taken large impairment write-downs. Due to these companies’ declining revenues, the carrying value of some of their long- term assets no longer exceeded the cash flows that they were meant to help gen-

erate. 3 Because of the write-downs, these companies reported large operating

losses.

Taking a large write-down in a bad year is often called “taking a big bath” because it “cleans” future years of the bad year’s costs and thus can help a com- pany return to a profitable status. In other words, by taking the largest possible loss on a long-term asset in a bad year, companies hope to reduce the costs of depreciation or amortization on the asset in subsequent years. 4

In the next few pages, we discuss the management issues related to long- term assets—how management decides whether it will acquire them, how it will finance them, and how it will account for them.